Historically, insolvencies track what’s going on in the economy – they rise ahead of recessions and fall back down with recoveries. For the first time in a decade, corporate insolvencies are increasing for developed markets across the globe. Atradius economists predict a nearly 3 percent increase in 2019, followed by another 1.2 percent uptick in 2020. Included in this outlook are developed markets in North America, Western Europe and Asia Pacific. While this could indicate a recession is on the way, it’s too early to panic.
A few major factors are feeding this trend, particularly the slowdown in the global economy and widespread trade policy uncertainty. Both circumstances make businesses feel unsure about the future and how to plan for it. This causes businesses to delay investment, leading to a self-inflicted negative cycle: they notice deterioration, delay investment, experience lower growth, and repeat. The September report from the Institute for Supply Management confirms business confidence is down for the second consecutive month.
U.S. Insolvencies Highest Among Developed Nations
U.S. businesses face a strong dollar, the unwinding of a pro-cyclical fiscal policy and are carrying higher average debt loads, limiting their flexibility when conditions deteriorate. Tariffs on Chinese imports are another pain point, particularly for the fragile retail sector, which is expected to shutter more than 12,000 stores in 2019. Thus, U.S. insolvencies are predicted to rise 3.2 percent in 2019 – 3 percent higher than in 2018 – and another 2 percent increase in 2020.
An increase in U.S. insolvencies has far-reaching effects. Insolvencies typically lead to lower employment, which dampens consumer spending. Big items like autos and homes come under pressure, impacting supply chains in heavy machinery, metals, manufacturing and retail. Canada and Mexico will experience the most pronounced effects from an increase in U.S. insolvencies, given how integrated supply chains are in North America.
While the U.S. has the highest predicted increase among countries monitored by Atradius economists, and it is certainly a downside risk, it’s important to remember that in 2007, when the Great Recession was blowing in, insolvencies increased 15 to 20 percent. Plus, after a decade of decreases, any increase in insolvencies is going to seem bigger simply because of the way percentages work.
Accommodative bankruptcy laws also contribute to the high insolvency increase compared with other developed markets. U.S. laws make it easy for companies to enter Chapter 11 – they’re designed to help companies with high debt loads or lease obligations quickly reorganize and emerge from bankruptcy status. In many other countries, an insolvency is an existential event. Businesses cease to operate and liquidate. This difference in severity means the U.S. insolvency rates can appear more volatile than in other parts of the world.
A spike in farm insolvencies is another factor pushing up the prediction for the U.S. Bad weather during planting season, including a lot of flooding in the Midwest, led to lower planted acreage, which in turn led to lower income for farmers. Many of them are hurting and declaring bankruptcy, which has implications all up the ag supply chain, increasing risk for durable goods, fertilizers and machinery. It doesn’t help that recent tariffs have targeted ag products, making the export of soybeans in particular difficult.
Business Environment Challenging in Western Europe
The outlook for Western Europe isn’t much brighter than that for the U.S. A 2.7 percent increase in insolvencies is expected, due to decelerating economic growth and lower global trade causing challenges for the manufacturing sector. The German automotive sector in particular is struggling.
Here, as everywhere, political uncertainty is a problem. The key drivers of the upswing in business failures include Brexit, which is expected to pose a negative risk into 2020. This is a problem particularly for markets with close economic ties to the UK, including Belgium, Denmark, the Netherlands and Ireland.
However, the forecast for the United Kingdom is the highest among Western European countries. Insolvencies there will likely increase 10 percent in 2019 and another 5 percent in 2020. This outlook could be revised upward or downward depending upon what happens with Brexit. Thus far, extensions of Article 50 have pushed back the UK’s departure from the EU, delaying the recovery of sterling, keeping inflation high, and prolonging the drag on business investment from uncertainty.
Looking Ahead
In 2020, monetary policy loosening in developed markets, including the U.S., will likely spur economic growth and business activity. Plus, global GDP growth is predicted to increase to 2.7 percent; this outlook, however, is based on the resolution of major trade differences.
The good news is that the factors causing the most uncertainty – trade tension between the U.S. and China and other major trading partners, Brexit – have the ability to resolve and stabilize. Plus, there is a chance the U.S. federal government will become more aggressive with rate cuts or embark upon a large deficit spending plan, which would stimulate the economy.
With risks remaining, however, businesses should become knowledgeable about local legal rules and regulations should a trading partner go bankrupt. Trade credit insurance can protect businesses against delayed or missing payment and can also help navigate complex bankruptcy laws.
Aaron Rutstein is vice president and director of risk services, Americas for Atradius Trade Credit Insurance, Inc. With more than a decade of experience in the trade credit insurance industry, Rutstein has developed expertise in business development, risk analysis, and buyer monitoring.